ECON30001 Problem Set 3.
Semester 1 2024
Question 1. Ann must choose between two actions, and the returns depend on whether there is sunshine (S) or rain (R). Action a increases her wealth by £600 in sunny weather, but decreases her wealth by £39 if it rains. Action b increases her wealth by £1,500 in sunny weather, but decreases her wealth by £600 if it rains. Ann is an expected utility maximiser with utility for money u(x) = √x and has wealth of £1,000. Ann believes there is a 75% chance of sunny weather.
Ann knows a meteorological expert, Bob, who predicts the correct weather with 75% pre- cision. That is, Bob sends messages s or r, and p(s|S) = p(r|R) = 0.75.
(a). What action will Ann choose if she does not use Bob’s information?
(b). What is the value (in utils) of Bob’s information for Ann?
Question 2. Ann and Bob are risk neutral expected utility maximisers (u(x) = x) playing the following game:
Ann and Bob share the belief that p(s1
) = 4/3.
Charlie is able to publicly reveal the true state of the world. What is the maximum amount that Ann and Bob would be willing to pay Charlie to stay quiet?